Businesses will see reduced rate of income for digital transactions

New Delhi, Dec. 22 -- Given the increased tax collections during the current financial year due to various measures taken by the government, such as the Income Disclosure Scheme, demonetisation and the Pradhan Mantri Garib Kalyan Yojana, there has been much speculation that the government would provide certain benefits to existing taxpayers.
There has been hope about higher income tax exemption slab, lower rates of tax, and other benefits. One measure has just been announced by the Central Board of Direct Taxes (CBDT), in a press release issued on Monday, 19 December.
Given the fact that many businesses have been forced to shift to digital transactions, which involves an additional cost, the CBDT has announced that the presumptive profit rate for small businesses under section 44AD would be reduced to 6% for bank and digital transactions, while remaining unchanged at 8% for cash transactions.
Though the change would be effected in the next budget, it would be applicable for the financial year 2016-17. How beneficial is this for small businesses?
The digital impact
Currently, these provisions apply to a business carried on by an individual, a Hindu Undivided Family (HUF) or a partnership firm, having a total turnover not exceeding Rs2 crore during the year.
It does not apply to a commission, brokerage or agency business. There is no change in these provisions, and hence the total turnover through cash, bank and digital transactions should not exceed Rs2 crore for the year.
The only effect is that the total turnover will now have to be segregated into two parts-that of bank and digital transactions, and that of cash transactions.
The profit of the business will be computed by taking the total of 8% of the cash turnover, and 6% of the bank and digital turnover. In a sense, the reduced profit for digital and bank transactions reflects the costs now borne by the business of processing credit card and digital transactions of customers.
An interesting issue is when the sales is on credit. The subsequent receipt, which may be after the end of the year, may be through bank or digital mode or cash. How does one compute the profit in such a case?
One would have to consider the manner of subsequent realisation, even though it is after the end of the year, and compute the profit accordingly.
Calculating profit
One important aspect that is often lost sight of by most taxpayers is that this presumptive profit is not necessarily the profit that one has to declare as one's income. It is the minimum profit that has to be declared by an eligible taxpayer under this provision.
If the actual profit is higher, the taxpayer has to declare the higher profit. For instance, if a taxpayer has earned Rs12 lakh on a turnover of Rs1 crore, the profit that he has to declare is Rs12 lakh, and not Rs8 lakh.
When the turnover was in cash, the majority of expenses were also in cash, since books of account are not required to be maintained in such cases.
The only way that one could measure whether the actual profit was higher than the presumptive profit rate was by taking the value of incremental investments made during the year out of profits, the cost of assets acquired during the year out of profits, and the amount of estimated personal expenses, and treating the sum of these as the profit.
If this was lower than 8% of the turnover, the income declared was 8%; if this was higher, such higher amount was to be declared as the profit.
Now that a significant part of the turnover would be received through digital or banking channels, it is highly likely that such funds would remain invested in the bank or other investments if amounts are not drawn from the bank for business expenses.
Therefore, the incremental investments are also likely to be higher, resulting in a higher business profit required to be declared, and not just 6% or 8%.
Further, the computation of the presumptive profit is based on the turnover. When the turnover was in cash, it was easy for a businessman to understate his gross turnover.
With a significant part of the transactions now being through bank or digital means, it will be difficult for a taxpayer to claim a lower turnover than the actual number.
The imminent introduction of the goods and service tax (GST), and the computerised GST network, would again make fudging of turnover figures difficult for such taxpayers.
Therefore, this proposed amendment would be of limited use to a small number of eligible taxpayers, who hitherto genuinely paid taxes based on their actual turnover. A majority of eligible taxpayers, who used to fudge their turnover figures, will end up paying tax on higher business profits, than they used to earlier, in spite of the reduced presumptive tax rate for digital and bank transactions.
Of course, this increased tax collection is more the positive impact of demonetisation and the shift to a greater role for digital transactions, rather than a fallout of the proposed amendment.